INFLATION &
DEFLATION
Inflation
Inflation is an economic indicator that
indicates the rate of rising prices of
goods and services in the economy.
Ultimately it shows the decrease in the
buying power of the rupee.
It is expressed as a percentage.
Increase in inflation indicates a decrease
in the purchasing power of the economy.
Types of Inflation
Demand-pull Inflation
Cost-push Inflation
Built-in Inflation
Demand-pull Inflation
It occurs when the demand for goods or
services is higher when compared to the
production capacity. The difference
between demand and supply (shortage)
result in price appreciation.
Example
Demand-pull inflation describes how
demand for goods and services can drive
up their prices. If something is in short
supply, you can generally get people to
pay more for it.
Are you still paying for plane tickets for a
vacation despite prices being
considerably higher than normal? That’s
a good example of demand-pull inflation.
Cost-Push Inflation
It occurs when the cost of production
increases. Increase in prices of the
inputs (labour, raw materials, etc.)
increases the price of the product.
When raw materials costs increase for
businesses, the businesses in turn must
raise their prices, regardless of demand.
Cost-Push Inflation
Built-in Inflation
As demand-pull inflation and cost-push
inflation occur, employees may start
asking employers for a raise. If
employers don’t keep their wages
competitive, they could end up with a
labor shortage.
Therefore, high wages result in
increased cost of production, which in
turn has an impact on product pricing.
The circle hence continues.
Who Benefits from Inflation?
Inflation being a cause of concern for the
economy, doesn’t affect everyone in a bad
way. It is a boon for a certain set of people.
While consumers lose a part of their purchasing
power to inflation, investors gain from it.
Investors investing in assets affected by
inflation, if held on for a long time will certainly
benefit from it. For example, an increase in
housing prices might affect consumers.
However, those who have already bought a
house will benefit from capital appreciation.
Deflation
Deflation is when consumables and
asset prices decrease over time, and
purchasing power increases.
Essentially, you can buy more goods or
services tomorrow with the same
amount of money you have today. This is
the mirror image of inflation, which is the
gradual increase in prices across the
economy.
Deflation – Is it good?
While deflation may seem like a good thing, it can
signal an impending recession and hard economic
times. When people feel prices are headed down,
they delay purchases in the hopes that they can
buy things for less at a later date. But lower
spending leads to less income for producers, which
can lead to unemployment.
This negative feedback loop generates higher
unemployment, even lower prices and even less
spending. In short, deflation leads to more
deflation. Throughout most of U.S. history, periods
of deflation usually go hand in hand with severe
economic downturns.
Consequences of Deflation
Unemployment. As prices drop, company
profits decrease, and some companies may cut
costs by laying off workers.
Deflationary spiral. This is a domino effect
caused by each overlapping piece of deflation.
Falling prices may result in less production.
Less production may lead to lower pay to
employees. Lower pay may result in a drop in
demand. And a drop in demand may cause
increasingly lower prices. And on and on. This
can make a bad economic situation worse.
THANK YOU